How can each one of the business-level strategies be used to position the firm relative to the five forces of competition in a way that permits the earning of above average profits?

University Degree Business and Administrative studies

Strategic Management MGT 451

Question 2

How can each one of the business-level strategies be used to position the firm relative to the five forces of competition in a way that permits the earning of above average profits?

Introduction

Competitive strategy is the basis for much of modern business strategy. Business level strategy is defined as an integrated and coordinated set of commitments and actions designed to provide value to customers and gain a competitive advantage by exploiting core competencies in specific, individual product markets (Hanson et. al., 2002). As we enter into the 21st century landscape, competition among firms is increasing and companies are committed to the importance of competing successfully in the global economy constantly scan developments in the world’s markets to identify emerging opportunities to exploit their competitive advantages.

Business-level strategies are used to be position the firm relative to the five forces of competition in a way that permits the earning of above average profits. The business unit level is the primary context of industry rivalry. The strategic business manager seeking to develop an edge over rival firms can use this model of Michael Porter’s five forces to understand the industry context in which the firm operates. Through this, it proves how the successful attainment of generic strategies of Porter can improve a firm’s relative power through the five forces that determine an industry’s average profitability (Ward and Griffiths, 1998).

Michael Porter’s Generic Strategies

Michael Porter presented three generic strategies that a firm can use to overcome the five forces and achieve competitive advantage. Each of Porter’s generic strategies has the potential to enable a firm to outperform rivals within the same industry. A firm positions itself by leveraging its strengths. Ultimately Porter argued that is strengths fall into three focuses on overall low cost (cost leadership), differentiation and focus. They outline the strategic options open to organizations that wish to achieve a competitive advantage.

Source: http://encyclopedia.thefreedictionary.com/Focus%20strategy

Porter’s Five Forces Analysis

The model of pure competition implies that risk-adjusted rates of return should be constant across firms and industries. The five forces influence a firm’s competitive strategy and this is why competitive advantage is critical for effective strategic management. Without competitive advantage, a company will be doomed to earn more than normal returns. Overtime, that company that perform below the level will have difficulty attracting and maintaining the level of investment estimates needed to continue operations (Ward and Griffiths, 1998).

If the primary determinant of a firm’s profitability is the attractiveness of the industry in which it operates, an important secondary determinant is in its position within that industry. By applying these strengths, these focuses of generic strategies mentioned above illustrates how they are applied at business level and how Michael Porter stressed that any industry in the global economy are influenced by the five forces.

Michael Porter provided a framework that models an industry as being influenced by the five forces known as supplier power, threat of substitutes, degree of rivalry, buyer power and barriers to entry. Five forces analysis helps the marketer to contrast a competitive environment. The proper generic strategy will position the firm to leverage its strengths and defend against the adverse effects of the five forces (Ward and Griffiths, 1998).

Overall Cost Leadership Strategy

The first generic strategy is known as overall cost leadership. Cost leadership requires a tight set of interrelated tactics that include:

Aggressive construction of efficient-scale facilities
Vigorous pursuit of cost reductions from experience
Tight cost and overhead control
Avoidance of managerial customer accounts
Cost minimization in all activities in the firm’s value chain such as R&D, service, sales force and advertising (Dess and Lumpkin, 2003).

The low cost leader in any market gains competitive advantage from being produced at the lower cost. This generic strategy calls for being the low cost producer ...

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Overall Cost Leadership Strategy

The first generic strategy is known as overall cost leadership. Cost leadership requires a tight set of interrelated tactics that include:

Aggressive construction of efficient-scale facilities
Vigorous pursuit of cost reductions from experience
Tight cost and overhead control
Avoidance of managerial customer accounts
Cost minimization in all activities in the firm’s value chain such as R&D, service, sales force and advertising (Dess and Lumpkin, 2003).

The low cost leader in any market gains competitive advantage from being produced at the lower cost. This generic strategy calls for being the low cost producer in any industry for a given level of quality (Ward and Griffiths, 1998). The firms sell its products either at average industry prices to earn a profit higher than that of rivals, or below the average industry prices to gain market share. In the event of a price war, profitability of the firm can be maintained while the competition suffers losses. Factories are built and maintained, labor is recruited to deliver the lowest possible costs of production. Cost advantage is the focus (Hanson et. al., 2002).

Empirical research on the profit impact of market share indicated that firms with a high market share were often quite profitable, but so were many firm with low market share. The least profitable firms were those with moderate market share (Pearce and Robinson, 2000). Porter explained that firms with a higher market share were successful because they pursued a cost leadership strategy and firms with low market share were successful because they used market segmentation to focus on a small but profitable market niche. Effective implementation of the cost of leadership strategy allows a firm to earn above-average returns in spite of the presence of strong competitive forces (Hanson et. Al., 2002).

An overall low cost or cost leadership enables a firm to achieve above-average returns despite strong competition. It protects a firm against rivalry from competitors because lower costs allow a firm to earn returns after its competitors eroded their profits through intense rivalry. Having the low-cost position serves as a valuable defense against rivals. Because of the cost leader’s beneficial position, rivals will hesitate to compete on the basis of price. Instead, they will try to compete in another area such as differentiation (Hanson et. al., 2002).

Bargaining power of buyers can force the cost leader to reduce its prices, but price will not be driven below the level at which the next-most-efficient competitor is able to earn average returns. A low cost position also protects firms against powerful buyers. Buyers in fact can exert power to drive down prices only to the level of the next-most-efficient competitors (Dess and Lumpkin, 2003).

Also a low cost position provides more flexibility to cope with demands from powerful suppliers for input cost increases. The cost leader operates with margins greater than those of competitors do. Among other benefits, higher margins relative to competitors’ make it possible for the cost leader to absorb suppliers’ price increases. When an industry is faced with actual increases in the cost of its supplies, the cost leader may be the only one able to pay the higher prices and continue to earn either average or above-average returns (Ward and Griffiths, 1998). However, the powerful cost leaders will be able to force suppliers to hold down their prices, reducing their margins in the process.

Besides that, the factors that lead to a low cost position also provide substantial entry barriers from economies of scale and cost advantages. Through continuous efforts to reduce costs to levels that are lower than competitors’, cost leaders become very efficient. This is because they enhance profit margins; ever-improving levels of efficiency serve as a significant entry barrier to potential entrants. To earn even average returns, new entrants must have the competencies required to match the cost levels of other companies (Dess and Lumpkin, 2003).

For an example, Dell Computers Corporation implemented its strategy with the Dell advantage, which is based on direct relationships, low cost, speed to market and e-commerce expertise as much as it is on Internet hardware, appliances and customer services and support. Dell was able to pass along to its customers the savings from reductions in system component costs quickly because it maintained very low inventories. Cost-efficiency has been reinforcing Dell as the competitive advantage in this PC industry. Low-cost assembly and efficient customer service has intimidate the trust of customers into Dell brand (, 2004).

In conclusion, this strategy emphasizes efficiency. By producing high volumes of standardized products, the firm hopes in advantages of economies of scale and experience curve effects. The product is often a basic no-frills product produced at a relatively low cost and made available to a very large customer base. This generic strategy can be used to position the firm relative to the five forces of competition in a way that permits the earning of above average profits.

Differentiation Strategy

A differentiation strategy calls for the development. Of a product or service that offers unique attributes that are valued by customers and that customers perceive to be better than or different from the products of the competition. Differentiation involves creating a product that is perched as unique. The unique features or benefits show superior value for the customer if this strategy is to be successful (Ward and Griffiths, 1998). Differentiation can take many forms such as prestige, technology, innovation, features, customer service or dealer network (Dess and Lumpkin, 2003).

Differentiated goods and services satisfy the needs of customers through a sustainable competitive advantage. This allows companies to desensitize prices and focus on how it generates a comparatively higher price and a better margin. The benefits of differentiation require producers to segment markets in order to target goods and derives at special segments, generating a higher than average price (Pearce and Robinson, 2000). The firm hopes that the higher price will more than cover the extra costs incurred in offering the unique product. Because of the product’s unique attributes, if suppliers increase their prices the firm may be able to pass along the costs to its customers who cannot find substitutes easily. Because customers competitive the product as unequaled, the price elasticity the demand tends to be reduced and customers tend to be more brand loyal. It provides considerable insulation from competition (Hanson et. al., 2002).

Firms that succeed in a differentiation strategy often have the following internal strengths:

access to leading scientific research
highly sale and creative product development team
strong sales team with the ability to successfully communicate the perceived strengths of the product
Corporate reputation for quality and innovation (, 2004).

Firms may differentiate themselves along several different dimensions at once. However, firms achieve and sustain differentiation advantages and attain above-average performance when their price premiums exceed the extra costs incurred in being unique.

Achieving differentiation is a viable strategy for earning above-average returns by creating a defensible position for overcoming porter’s five competitive forces. Differentiation provides protection against rivalry since brand loyalty lowers customer sensitivity to price and raises customer-switching costs. By increasing a firm’s margin, differentiation avoids the need for a low cost position (Dess and Lumpkin, 2003). Higher entry barriers result because of customer loyalty and the firm’s ability to provide uniqueness in its products or services. Differentiation also provides higher margins that enable a firm to deal with supplier power and it reduces buyer power because buyers lack comparable alternatives and are therefore mess price sensitive. Supplier power is also decreased because there is a certain amount of prestige associated with being the supplier to a producer of highly differentiated products and services. Last, a firm that uses differentiation will enjoy high customer loyalty, thus experiencing less threat from substitutes than its competitors (Dess and Lumpkin, 2003).

For example, having a powerful brand image forms the foundation of the success of the BMW Company, being one of the few multi-model carmakers in the world to concentrate exclusively on the premium segments of the automobile market. BMW is small in size comparison with competitors in the industry but implements strategy of differentiation (Dess and Lumpkin, 2003). BMW's strategy is to continue to concentrate on market offensives in the premium segment while continuing to focus on quality, innovation and excellence. Stretching the brand image by diversification is another option enabling them to remain in a highly competitive position. Lack of experience in multi brand production this has resulted in non-diversifications to other segments such as commercial vehicles and heavy vehicles, whereas competitors have spread over all the segments in the automobile industry. However, there is always a particular risk of differentiation strategy.

In conclusion, the differentiation strategy once again has showed us that it can position a firm relative to the five forces of competition in a way that permits the earning of above average profits.

Focus (Market Segmentation) Strategy

The focus (or market segmentation), strategy concentrates on a narrow segment and within that segment attempts to achieve either a cost advantage or differentiation (Pearce and Robinson, 2000). The premise is that the needs of the group can be better serviced by focusing entirely on it. A firm using a focus strategy often enjoys a high degree of customer loyalty, and this entrenched loyalty discourages other firms from competing directly.

In this strategy, the firm concentrates on a select few target markets. The focus strategy is also known as a ‘niche’ strategy. Where an organisation can do neither a wide scope cost leadership nor a wide scope differentiation strategy, a focus strategy could be more suitable. Competitive advantage is generated specifically to the niche. Smaller firms normally use a niche strategy (Ward and Griffiths, 1998). Because of their narrow market focus, firms pursuing a focus strategy have lower volumes and thus less bargaining power with their suppliers. However, firms pursuing a differentiation-focused strategy may be able to pass higher costs on to customers since close substitute products do not exist.

This third generic strategy is based on the choice of a narrow competitive scope within an industry and achieves competitive advantage by dedicating itself to these segments exclusively. The essence of focus is the exploitation of a particular market niche that is different from the rest of the industry. The firm typically looks to gain a competitive advantage through effectiveness rather than efficiency (Dess and Lumpkin, 2003).

Firms that succeed in a focus strategy are able to tailor a broad range of product development strengths to a relatively narrow market segment that they know very well (Stacey, 1993). In contrast to firms that implement the cost leadership and differentiation strategies, a company that employs a focus strategy seeks to use its core competencies to serve the needs of a certain industry segment. Firms can either choose to use focused cost leadership strategy or focused differentiation strategy. For example, IKEA the global furniture retailer seeks to provide customers with a low cost make up of the focused cost leadership strategy (Hanson et. al., 2002).

Focus strategy requires that a firm either have a low-cost position with its strategic target, high differentiation, or both. As it has been discussed with regard to cost and differentiation strategies, these position provide defenses against each competitive force. Focus is also used to select niches that are least vulnerable to substitutes or where competitors are weakest.

For example, the BODY SHOP is the leading company to focus on that group of women who want chemical-free cosmetics made from ‘natural ingredients’ and without being tested on animals. BODY SHOP may be able to focus on a more narrowly defined competitive segment and ‘out-focus’ the focuser. BODY SHOP has used its reputation for environmental work based on the generation of publicity in the area to differentiate itself from other firms in a tight market. And today, we could see BODY SHOP is found doing well around the world (Hanson et. al., 2002).

Bibliography:

Hanson, D., Dowling, P., Hitt, M.A., Ireland, R.D., and Hoskisson, R.E, 2002, Strategic Management – Competitiveness and Globalisation, Nelson Australia Pty Limited, Victoria

Dess, G.G., and Lumpkin, G.T., 2003, Strategic Management – Creating Competitive Advantages, McGraw-Hill Higher Education, California.

Pearce, J.A., and Robinson, R.B., 2000, Strategic Management - Formulation, Implementation and Control, McGraw-Hill Higher Education, Boston.

Ward, J., and Griffiths, P., 1998, Strategic Planning for Information Systems, John Wiley & Sons, New York.

Stacey, R., 1993, Strategic Management and Organizational Dynamics, Pitman, London.

QuickMBA – Strategic Management, </strategy/porter.shtml>, 2004

Dell Computers Corporation, <>, 2004

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